Many or all companies we feature compensate us. Compensation and editorial
research influence how products appear on a page.
Small Business Loans

How Do Small Business Loans Work?

For many entrepreneurs, securing a small business loan is critical to realizing their business dreams. Whether it’s launching a startup, sustaining day-to-day operations, or expanding operations, the right financing can be one of the keys to success. 

Even so, figuring out how to get a small business loan can be complex—understanding how small business loans work is essential so you can make an informed decision about what’s right for you and your business. 

We’ll explore the ins and outs of small business loans, including where and how to obtain them. 

What is a small business loan?

A small business loan provides owners with the capital needed for their business. The loan funds can be used to finance almost any business need, including starting a business, maintaining its operations, or funding continued growth. 

Owners use small business loans for purposes such as:

  • Starting a business: New businesses can use the loan proceeds to fund their startup costs, such as buying equipment and funding working capital. 
  • Covering day-to-day operating costs: Businesses often need funds to help cover their short-term operational costs, commonly called working capital.  
  • Purchasing inventory: Retailers often use business loans to cover the cost of their inventory purchases while waiting for the inventory to sell. 
  • Buying machinery, equipment, or real estate: Small business loans can fund the long-term assets businesses need for their operations, whether it’s buying a store, warehouse, or office space. The funds can also be used to buy machinery or equipment.
  • Growing the business: As businesses grow, their funding needs expand, and small business loans can help fund this growth. 

Over time, the funding needs of each business will change. Small business loans can help businesses in every stage of their life cycle. 

How do small business loans work?

A small business loan is an arrangement where a business borrows money from a lender and agrees to repay it per an agreed-upon set of terms. The specific loan terms will vary depending on the type of loan the business gets, the conditions of the loan, and the lender. 

Two common types of small business loans are installment loans and lines of credit. With an installment loan, a business receives a lump sum and agrees to repay it over a set period. Lines of credit allow businesses to borrow and repay money as needed, similar to a credit card. 

These loans can be secured by collateral or unsecured. With a secured loan, the business pledges collateral the lender can take ownership of if the loan isn’t repaid as agreed. Collateral can be almost any business asset: equipment, machinery, real estate, inventory, or accounts receivable.  

An unsecured small business loan isn’t backed by collateral. Lenders take more risk with an unsecured loan because there’s no collateral to cover the balance if the borrower defaults. So it’s harder to qualify for this type of loan, and the interest rates are often higher. 

Our expert recommends: Do this first

Erin Kinkade


I recommend that business owners generate an advisory board of professionals familiar with their line of business (CPA, consultant, advisor or planner, and attorney). This will aid in understanding what needs to be done and the considerations associated with each decision when applying for a loan and other startup costs. Recruiting this team can take time and could have a high price tag, but it will help the business owner start on the right foot, save money, and make more money in the long run. This is a critical step I see small business owners skip or forgo—some knowingly and some not—due to the cost of time and money.

Types of small business loans

Small business owners often require financial assistance to start, operate, or grow their businesses. Some of the most common small business loans are term loans, lines of credit, SBA loans, real estate loans, equipment loans, working capital loans, and invoice factoring.

Each type serves different purposes and comes with its own terms, conditions, and repayment structures, providing business owners with flexibility in securing funding tailored to their specific needs.

Type of small business loanHow it works
Small business term loanLump sum
Fixed repayment schedule over a set term

Often used to buy long-term assets
Small business line of creditRevolving credit
Access funds up to a set credit limit

Cover short-term expenses
SBA loanGuaranteed by U.S. Small Business Administration

Favorable terms for working capital, equipment, and real estate
Real estate loanPurchase or refinance commercial properties

Longer terms and lower rates than other term loans
Equipment loanFinance equipment purchase

Equipment serves as collateral

Term matches useful life of equipment
Working capital loanShort-term funding for operational expenses

Can help manage cash flow gaps or fund growth
Invoice factoringSell accounts receivable to a factor at a discount for immediate cash flow
Cover quick funding needs

Small business term loan

What is it?

A small business term loan is a single sum you borrow from a lender with a set repayment schedule over a fixed period, often ranging from one to five years or longer. 


Common uses include large funding needs, such as real estate, equipment, business expansion, or long-term projects. 


Interest rates on business term loans can be fixed or variable, and repayment is often made in regular installments, including principal and interest, until the loan is repaid.

Small business line of credit

What is it?

A small business line of credit offers access to a revolving credit line, allowing the business to borrow funds up to a set credit limit as needed. Borrowers only pay interest on the amount used, and once the principal is repaid, the full credit line becomes available again. 


This flexibility makes lines of credit suitable for managing cash flow fluctuations, covering short-term expenses, or seizing opportunities for business growth—without the hassle of a new loan application every time you need funds.

SBA loan

What is it?

An SBA loan is guaranteed by the U.S. Small Business Administration (SBA). Designed to support small businesses that may not qualify for traditional financing, many SBA loans offer more favorable terms, lower down payments, and longer repayment periods than conventional small business loans. 


SBA loans can be used to cover working capital needs, fund equipment purchases, or acquire real estate, making them a terrific option for small business owners seeking affordable funding.

Real estate loan

What is it?

A real estate loan, aka a commercial mortgage, is designed to fund the purchase or refinancing of commercial properties, including office buildings, retail spaces, or warehouses, used for business purposes. 

How it works

Business real estate loans often have longer terms and lower rates than other types of loans, reflecting the collateral value of the financed property. The terms can extend as long as 30 years, similar to a residential mortgage. 

Equipment loan

What is it?

An equipment loan can help you finance the purchase of equipment and machinery for business operations, such as vehicles, computers, manufacturing equipment, or specialized tools. 

How it works

The financed equipment is collateral for the business loan, reducing the lender’s risk and often resulting in favorable loan terms. This type of business loan often has fixed interest rates and repayment terms aligned with the expected useful lifespan of the equipment (e.g., three to 10 years).

Working capital loan

What is it?

A working capital loan provides short-term funding to cover day-to-day operational expenses, including payroll, inventory restocking, rent, utilities, and marketing. These loans help businesses manage cash-flow gaps or seize opportunities for growth by providing immediate access to capital. 

How it works

Depending on the borrower’s need and lender’s preferences, this business loan type can be secured by collateral or unsecured. The repayment terms on working capital loans can range from several months to a few years, based on what’s best for the individual business.

Invoice factoring

What is it?

With invoice factoring, businesses sell their accounts receivable (invoices) to a third-party lender (known as a factor) at a discount. The factor gives a portion of the invoice to the business upfront, typically 70% to 90%, and collects the invoice payment from the customer.

After the customer has paid the invoice in full, the factor deducts its factoring fee and then sends the remaining proceeds to the business. 

Invoice factoring can be costly, but it provides immediate access to cash flow without waiting for customers to pay. This can make it a suitable solution for businesses with slow-paying clients, seasonal revenue fluctuations, or financial issues limiting access to other small business loans. 

Where to get a small business loan

Many banks, credit unions, and online lenders offer small business loans. Some lenders offer a streamlined application process similar to applying for a personal loan. 

Financial institutions also have small business lending departments, with expert lenders well-versed in small business finance. If you’re unsure what type of business loan is best for your situation, a skilled commercial lender can help you determine the correct type of financing. 

If you’re unsure where to begin looking for a small business loan, the SBA administers a network of Small Business Development Centers (SBDCs) nationwide. The SBDCs are designed to offer businesses the guidance and support they need to survive and thrive. 

The SBA also supports the nonprofit SCORE, an entity designed to provide business owners with mentorship and training opportunities. Through your local SCORE office, a mentor may be able to offer you free guidance about where and how to get financing in your area. 

How to get a small business loan

To get a small business loan, you must show that your business is willing to repay the business loan. When reviewing your loan application, the lender will analyze the creditworthiness of your business. 

Many lenders use the five Cs of credit to evaluate your business loan application: 

  1. Character: Demonstrates your trustworthiness and reliability, often assessed through your personal and business credit history and references from suppliers or other creditors. 
  2. Capacity: Relates to your business’s ability to repay the loan based on its historical and future cash flow, revenue, and profitability. Lenders often evaluate the debt service coverage ratio (DSCR) to ensure the business can manage the payments.
  3. Collateral: Refers to business assets, such as real estate, equipment, or inventory, that you provide as security for the loan. Collateral reduces the lender’s risk if they don’t repay it as agreed.
  4. Capital: Indicates the amount of money you have invested in your business, reflecting your commitment and financial stability. It can also refer to the size of a down payment you can make on an asset purchase (e.g., real estate or equipment). 
  5. Conditions: Considers external factors, including the economic environment, industry trends, and the purpose of the loan. It assesses the risk associated with the loan and your business.

This will vary by lender, but you must often provide business financial statements and tax returns for the most recent two or three years. You may also need to share collateral details, projections, a business plan, resumes for the managers, and financial information for the primary owners. 

Understanding and being prepared to address these factors can improve your chances of getting the loan you need to grow and succeed. By demonstrating your business’s strength across these areas, you can build trust with lenders and position yourself for financial success.


How long do you have to pay back a small business loan?

The repayment period for a small business loan varies depending on the lender and the type of loan. You may need to repay short-term loans within a year, but more substantial loans can have terms ranging from five to 25 years.

How easy is it to get a small business loan?

The ease of obtaining a small business loan depends on several factors, including your credit history, the financial health of your business, and the lender’s criteria. 

It’s more challenging for new businesses or those with poor credit. But various loan options are available, and preparation, such as having a solid business plan and financial records, can improve your chances.

What credit score is needed for a small business loan?

The required credit score for a small business loan can vary between lenders. Traditional banks may require a score of 700 or above, but alternative lenders might accept lower scores. A higher credit score often leads to better loan terms, such as lower interest rates.